There are numerous ways Apple could change the physical size of the iPhone, but none of them are painless or easy fragmentation-wise. Rene Ritchie does a good job here analyzing Apple’s options.

My money remains on changing the aspect ratio and keeping the pixel density the same. Going from the current 3:2 aspect ratio 960 × 640 display to something like a 9:5 1152 × 640 display. Yes, this would introduce a new headache for developers, but iPhone apps are already supposed to be somewhat flexible vertically, to account for the double-height status bar when there’s an active phone call or audio recording.

And don’t forget the operations angle. My understanding is that these displays aren’t manufactured at their finished sizes — they’re manufactured in big sheets that are then cut to size. So instead of ramping up manufacturing of an entirely new display, Apple would simply be cutting slightly larger displays out of the same “iPhone retina display” sheets they’ve been producing ever since the iPhone 4 hit production.

Lastly, the above is only my conjecture if Apple were to switch to a larger iPhone display. If Apple changes the iPhone display size, this is how I think they’ll do it. I still think that’s a big if, though, and wouldn’t be surprised in the least if this year’s iPhone ships with a good old-fashioned 3.5-inch 960 × 640 display.